What does the future hold for battered banks?
Anyone that has been investing in banking stocks over the past year will probably be nursing heavy losses because the share prices of many leading names have collapsed on the back of the devastating credit crunch.
But it hasn’t just been shareholders in individual companies who have suffered as a result of the problems in the banking sector, as Rebecca O’Keeffe, head of fund management at Interactive Investor, points out. Those investing in funds have also been hit.
"The Equity Income sector, which is home to some of the biggest UK funds and big name fund managers, has been battered over the last year and is down 21% on average," she says. "However, the best performing fund - Threadneedle’s UK Equity Income is only down 10% because it has limited its financial exposure to 18%. However, the worst performing fund, the New Star Higher Income, is down 35% in the year as it’s been hurt by its exposure to banks and other financial stocks."
The fact that banks make up 15.42% of the blue-chip FTSE 100 index of leading shares has added to the general air of gloom. When such a significant chunk is in difficulties it can’t fail to impact on the market’s overall performance. This is illustrated by the figures. The index, which consists of seven banks, has plummeted from 6,590 points to 5,426 over the year to 2 July 2008. This represents a painful 18% fall for investors.
It’s been a time of shock and confusion for investors. So what exactly is going on?
The problem is that the banking industry has been at the very centre of the economic problems that have swept the globe and so has best been avoided, explains Geoff Penrice, a financial adviser at Bates Investment Services. "The sub-prime mortgage problems in the US, the general economic slowdown and falling house prices are the three main reasons why they’ve been struggling," he adds. "Banks have certainly not been the place to be."
The seriousness of the situation was illustrated when three household names announced plans to raise huge sums - by issuing new shares to existing shareholders in a procedure known as a rights issue - to shore up their balance sheets. The Royal Bank of Scotland (RBS) was the first to move, with the launch of a £12 billion rights issue; HBOS revealed it needed £4 billion; while Bradford & Bingley is looking to get its hands on almost £400 million. Barclays is also seeking to raise £4.5 billion and to bolster its balance sheet by issuing new shares to a variety of investors.
Essentially, this is all about owning up to past mistakes, explains Andy Gadd, head of research at Lighthouse Group. "Shareholders in banks have got to accept that, ultimately, they own the banks, and any losses arising from the credit crunch and inadvisable past lending policies have got to be paid for," he says. "The cash injection from a rights issue is designed to ensure the financial strength of banks going forward."
Cap in hand
However, just whether or not these share issues will do the job remains to be seen, warns Nick Clay, manager of the Newton Managed fund, and the big fear now is that banks will once again be knocking on investors’ doors. "The rights issues have not been big enough and we think they will have to come back and have another go," he claims. "These banks have virtually no bad debts at the moment, but this is going to materially change."
While banks in the UK and the US are undoubtedly suffering, Penrice is at pains to point out that not all banks have been equally affected.
"Those which are geographically well-diversified have fared OK, especially those with exposure to strong economies such as Brazil, India and Russia," he explains. "This means that names such as HSBC and Standard Chartered have held up relatively well." In fact, the share prices of both banks are not too far off the levels they were a year ago. This can be considered quite an achievement considering the vast majority of their ‘rivals’ have lost at least half their value over this period.
According to Nick Clay, the explanation for this is that Asia is still in the throes of recovering from the financial crisis that gripped the region a decade ago and, therefore, their banks are at a completely different stage in the cycle. "People haven’t got many mortgages out there and the property market has been fairly subdued," he explains. "At the moment, they also have lots of savings and may well be thinking about taking out loans to fund purchases."
As to the outlook for financials, opinion among the fund management community is pretty divided, according to Rebecca O’Keeffe. "The jury is split, with some very senior fund managers heralding banks as an opportunity," she says. "However, with the UK housing market on the rocks, household debt a severe issue and general stockmarket sentiment poor - as well as the numerous rights issues - it’s a difficult call."
The question is whether the overall outlook is expected to improve over the coming months, and that is unlikely, according to Ralph Brook-Fox, a UK investment manager at Resolution Asset Management, who manages both the Higher Yield and UK Focus funds.
In fact, Brook-Fox says, things are still expected to deteriorate before any improvement takes place. "Valuations are at very low levels but news flow remains pretty terrible, with credit write-offs, capital raising and rising impairments," he adds. "This seems unlikely to end any time soon and we are waiting for the likely big rise in mortgage arrears and defaults before being tempted back in."
Graham Ashby, head of income funds for Credit Suisse Asset Management, is in agreement. The fund group hasn’t got any exposure to the three banks involved in the fund raising, he says, and has been reducing exposure to banks as a whole.
"Instead, we’ve focused our portfolio in companies which have strong balance sheets and where we believe there’s potential for long-term dividend growth," he explains. "To many people’s surprise, this includes many stocks elsewhere in the financials sector, such as Lloyd’s insurer Amlin."
It's not just banks
Here, Ashby raises an important point. The financial sector doesn’t solely consist of banks, but also insurers, life companies, software manufacturers and even property companies. However, although they may not be directly exposed to the problems in the wider economy, many have been found guilty by association.
For example, the share price of ICAP, which is involved in broking services, has come under pressure even though its business remains unaffected by the economic issues. In fact, the fundamentals of the company remain very strong.
"ICAP has no exposure to the problems of the banks, so has been hit for no reason," agrees Clay at Newton. "Eventually, when everything settles down again, there will probably be some very good opportunities for investors."
Bill Mott, manager of the Psigma Income fund, has been far more positive on financials, and has exposure to names such as HSBC, Standard Chartered, Lloyds TSB, HBOS, RBS and Barclays. In fact, banks account for 14% of the assets under management in the £398.2 million portfolio.
"We do not own Bradford & Bingley and Alliance & Leicester, although they may well offer stunning investment opportunities over the next few months," he says. "It’s not our current intention to increase our relative weighting in the banks unless a cataclysmic event occurs. Life assurance remains our biggest overweight relative stance in the fund."
So where does this leave investors? Should you take advantage of the malaise in financials to buy at relatively low levels, or is it best to sit tight for a few more months to see if there are more nasty surprises in store? According to Andy Gadd, it all depends on your financial goals. Anyone looking to cash-in by making a bumper profit through buying and selling over the next few months needs to think again.
"If you’re prepared to take a medium to long-term view - a minimum of five years - then there are potentially some great opportunities in the financials sector at the moment," he says. "I’m a fan of the New Star Global Financials fund. I like the fact that there’s a global remit and Guy de Blonay, the fund manager, has managed the fund since its launch in 2001."
Geoff Penrice agrees. "The fact that these shares have performed badly is no reason not to invest in them," he says. "We know that the best gains are to be made by buying shares which are under pressure and low in value. Assuming the banks don’t go bust, then this is probably a good time to invest."
That might be the case, but the evidence still isn’t compelling enough to make investing in the sector a no-brainer, argues Mark Dampier, head of research at Hargreaves Lansdown. "You shouldn’t be rushed into doing anything immediately," he advises. "The chances are that there could still be further bad news to come, so there’s no need to start panic-buying. There’s still plenty of time."
All sub-prime financial products are aimed at borrowers with patchy credit histories and the term typically refers to mortgage candidates, though any form of credit offered to people who have had problems with debt repayment is classed as sub-prime. Depending on the lender’s own criteria, sub-prime can apply to borrowers who have missed a few credit card or loan repayments to people who have major debt problems and county court judgments (CCJ) against their name. To reflect the extra risk in lending to people who have struggled in the past, rates on sub-prime deals are typically higher than for “prime” borrowers.
The general term for the rate of income from an investment expressed as an annual percentage and based on its current market value. For example, if a corporate bond or gilt originally sold at £100 par value with a coupon of 10% is bought for £100 then the coupon and the yield are the same at 10%, or £10. But if an investor buys the bond for £125, its coupon is still 10% (or £10) and the investor receives £10 but as the investor bought the bond for £125 (not £100) the yield on the investment is 8%.
A way a company can raise capital by creating new shares and invite existing shareholders in the company to buy these additional shares in proportion to their existing holding to avoid a dilution of value, which means keeping a proportionate ownership in the expanded company, so that (for example) a 10% stake before the rights issue remains a 10% stake after it. As an added incentive, the new shares are usually offered below the market price of the existing shares, which are normally a tradeable security (a type of short-dated warrant) and this allows shareholders who do not wish to purchase new shares to sell the rights to someone who does.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
Generally thought of as being interchangeable with insurance but isn’t. Assurance is cover for events that WILL happen but at an unspecified point in the future (such as retirement and death) and insurance covers events that MAY happen (such as fire, theft and accidents). Therefore you buy life assurance (you will die, but don’t know when) and car insurance (you may have an accident). Assurance policies are for a fixed term, with a fixed payout, and unlike life insurance have an investment aspect: as a life assurance policy increases in value, the bonuses attached to it build up. If you die during the fixed term, the policy pays out the sum assured. However, if you survive to the end of the policy, you then get the annual bonuses plus a terminal bonus.
If you own shares in a company, you’re entitled to a slice of the profits and these are paid as dividends on top of any capital growth in the shares’ value. The amount of the dividend is down to the board of directors (who can decide not to pay a dividend and reinvest any profits in the company) and they will be paid twice yearly (announced at the AGM and six months later as an interim). Dividends are always declared as a sum of money rather than a percentage of the share’s price. Although dividends automatically receive a 10% tax credit from HM Revenue & Customs (HMRC), which takes the company having already paid corporation tax on its profits into account. Dividends are classed as income and, as such, are liable for personal taxation and so shareholders have to declare them to HMRC.
“Arrears” tend to be associated with debt. If you fall behind and miss payments on any outstanding debt, the amount you failed to pay is an arrear – the amount accrued from the date on which the first missed payment was due.
An individual employed by an institution to manage an investment fund (unit trust, investment trust, pension fund or hedge fund) to meet pre-determined objectives (usually to generate capital growth or maximise income) in prescribed geographic areas or investment sectors (such as UK smaller companies, technology or commodities). The manager also carries the responsibility for general fund supervision, as well as monitoring the daily trading activity and also developing investment strategies to manage the risk profile of the fund.